Ms. Gloria Blue Office of Policy Coordination U.S. Trade Representative Submitted via December 13, Dear Ms. Blue:

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1 Ms. Gloria Blue Office of Policy Coordination U.S. Trade Representative Submitted via December 13, 2002 Dear Ms. Blue: Please find attached the Semiconductor Industry Association's submission to the 2003 National Trade Estimate Report on Foreign Trade Barriers. SIA represents over 90 percent of America s semiconductor industry. Today, U.S. semiconductor firms are global leaders, commanding over half of worldwide market share. Overseas sales account for more than 60 percent of SIA members revenues, with the importance of foreign markets expected to grow. American chipmakers are successful when they are able to compete on fair terms. Consequently, it is vital to our industry to continue eliminating tariffs and trade barriers in order to gain equal access to world markets. Today, China represents the fastest growing market in the world for semiconductor products. Consequently, SIA member companies continue to be very interested in China s compliance with its World Trade Organization (WTO) commitments. While we believe China is making efforts to meet its WTO obligations, intellectual property protection, state-owned enterprise purchases, trade regime reform, investment restrictions, and promotional policies remain areas of concern, as detailed in our submission. A major issue for our sector in China is the differential Value Added Tax (VAT) as it is applied to domestic versus foreign semiconductors. Discrimination against imported semiconductors through the VAT rebate policy is inconsistent with National Treatment under GATT Article III. While we chose to focus our NTE comments on the priority issues in China, our industry also faces non-tariff barriers to trade in other areas of the world. Potential barriers include excessive regulation and formulation of product standards. SIA requests the support of the U.S. government in ensuring these regulations and policies do not become trade-adverse, by enforcing WTO regulations on technical barriers to trade. Environmental, health, and safety regulations in our industry have become increasingly important. As countries develop new regulations, they should proceed in a transparent manner involving all stakeholders. The regulations should be proportional to the objective, justified by sound science, enforced in a nondiscriminatory manner, and subject to appeal and judicial review. In the technology sector, standards can determine the fate of an individual firm. We urge governments to allow the market to drive product and network standards, and to avoid selecting winners through standard-setting. Any government standard formulation should be done through a transparent process that involves all affected parties. SIA appreciates the opportunity to provide input to the 2003 National Trade Estimate Report. We look forward to continuing our work with the U.S. government to level the playing field for American semiconductor firms in markets throughout the world. Sincerely, George Scalise President Semiconductor Industry Association

2 COMMENTS OF THE SEMICONDUCTOR INDUSTRY ASSOCIATION FOR THE 2003 NATIONAL TRADE ESTIMATE REPORT ON FOREIGN TRADE BARRIERS December 13, 2002 The Semiconductor Industry Association (SIA) submits the following comments regarding the 2003 National Trade Estimate (NTE) Report on Foreign Trade Barriers: Recommendation CHINA SIA recommends the inclusion of language in the China chapter of the 2003 NTE Report on the following issues: (1) value-added tax (VAT) rebate for domestically-produced semiconductors; (2) end-use certification requirement for Information Technology Agreement (ITA) products; (3) intellectual property protection; (4) purchasing practices of China s stateinvested enterprises; (5) trade regime reform; (6) investment restrictions; (7) Chinese promotional policies for domestic semiconductor producers. 1. VAT Rebate China applies a VAT of 17 percent on sales of all imported and domestically-produced semiconductors and integrated circuits. In June 2000, China's State Council announced that integrated circuits manufactured within China will receive an 11 percent rebate on the VAT, effectively applying only a 6 percent VAT to these products. 1 In September 2001, a senior Chinese government official announced that integrated circuits designed and built within China will be eligible for a 14 percent VAT rebate, amounting to a 3 percent applied VAT. In October 2002, the Ministry of Finance (MOF) and State Administration of Taxation (SAT), with the blessing of the State Council, jointly issued a new circular that reinforces Document 18 and mandates that the 14 percent VAT rebate be enforced. 2 Another recent circular extends a 6 percent applied VAT to integrated circuits (ICs) designed in China, with their proprietary intellectual rights remaining in China, but produced overseas where such ICs cannot be manufactured in China due to export control laws or otherwise. 3 Moreover, additional tax incentives traditionally given to the power and transportation industries have been granted for technology projects that have an investment greater than RMB 8 billion (approximately $1 billion) and/or produce integrated circuits that are smaller than 0.25 microns. Discrimination against imported semiconductors through the VAT rebate is inconsistent with China's WTO obligations. GATT Article III (on National Treatment ) establishes a general prohibition against a WTO member engaging in activity that discriminates in favor of domestic products at the expense of imported products. Specifically, paragraph 2 of State Council Document Number 18 MOF & SAT Circular No. (2002)70 MOF & SAT Circular No. (2002)140

3 Article III states that a WTO member cannot impose taxes on imported products that are greater than those imposed on domestic products. China s VAT rebate policy for locally-produced or designed semiconductors violates this basic WTO principle. Prior WTO decisions establish that tax credits or rebates to domestic manufacturers, without similar provisions for foreignmanufactured products, are in violation of the national treatment clause. While China does extend the VAT rebate to both domestic and foreign-owned facilities located within China, the differing treatment of domestic production and foreign imports is a violation of China's national treatment commitment. Any tax imposed on imported goods must be collected in a nondiscriminatory manner. Moreover, providing favorable tax treatment to products based on the domestic origin of any part of their product development whether it is design, manufacturing or assembly remains discriminatory under GATT Article III. China's $15 billion semiconductor market is the third largest globally, and enjoys the world's highest growth rate. By 2010, China is predicted to be the world's second largest market for semiconductors, behind only the United States. China s domestic semiconductor industry is rapidly building production capacity, as outlined in the Chinese government's 10th Five-Year Plan, which aims to increase Chinese semiconductor output from $2 billion in 2000 to $24 billion in According to these projections, Chinese local production could satisfy 50 percent of domestic demand by 2010, versus the current 15 to 20 percent. China's IC industry attracted $3.6 billion of new investment from 2000 to 2002, with investment projected to reach $12 billion by 2005 and $25 billion by If imported semiconductors are subject to 14 percent more in value-added taxes, foreign producers will be further disadvantaged as Chinese production capacity ramps up and competition between imports and domestic production increases. The best solution for U.S. export interests and the development of China's information technology market is for the PRC to reduce or eliminate the VAT rate for all semiconductors and integrated circuits, regardless of origin. As was the case with tariffs on semiconductors (which were eliminated as of January 1, 2002, as part of China's accession to the WTO), VAT charges impose added costs for key components of personal computers, cellular telephones and other important electronic items being produced in China. Thus, a high VAT on imported semiconductors would not only continue to limit access for foreign producers to the Chinese market, but would impair the development of China's IT sector and deprive the Chinese economy of the benefit of improvements in technology. In addition, the high VAT on imported semiconductors will encourage renewed smuggling of this high-value product into China. Reports indicate that China s elimination of semiconductor tariffs (formerly 6-9%) has succeeded in significantly reducing smuggling of semiconductors into China. But a high differential VAT rate on imported semiconductors will provide a new incentive for smuggling, and run counter to the high priority the Chinese government has placed on eliminating illegal entry of goods. 4 Figure includes locally-based foreign producers. 5 "IC Industry Set for Torrent of Investment in Next Decade," People's Daily Online, November 18,

4 2. End-Use Certification Requirement For ITA Products Consistent with its commitment to join the Information Technology Agreement (ITA) as part of its WTO accession, China eliminated its tariffs on semiconductors in January The elimination of tariffs on ITA products benefits both U.S. producers and Chinese consumers. However, the Ministry of Information Industries (MII) and the Ministry of Finance introduced a new decree in January 2002 requiring an end-user certificate on 15 ITA products, including some semiconductor manufacturing equipment. 6 The end-user certificate, required to receive the lower ITA tariff rates, is issued only after the MII deems the imported items are being used to produce other Chinese information technology (IT) products. During the ITA negotiations, the use of end-use certificates was considered and rejected as unnecessary and burdensome. China s end-use certificate requirement is contrary to the ITA and adds administrative costs for U.S. chipmakers seeking to import semiconductor manufacturing equipment into China. More importantly, if China is allowed to maintain an enduse certification program, it would set a dangerous precedent that is in neither the United States nor China s interest as efforts continue to expand the ITA to additional countries. 3. Intellectual Property Protection China must adhere to its commitment to improve intellectual property protection. China agreed to comply with all TRIPS Agreement obligations immediately upon its WTO accession. SIA urges the U.S. Government to continue its work with China to ensure full and effective enforcement of these laws. Adequate protection of intellectual property rights will encourage the high technology foreign investment China seeks to promote the development of its economy. Accession to the WTO required China to enact specific legislation to extend intellectual property protection to semiconductor layout designs (maskworks) consistent with TRIPS. On March 28, 2001, China s State Council passed the Regulation on Integrated Circuit Layout Design Protection as part of its preparations to join the WTO. The regulation took effect October 1, Last year, a Chinese official had made a statement that discrete semiconductors were not protected under the new maskworks law, raising U.S. industry concerns. SIA is pleased to report that the Chinese State Intellectual Property Office (SIPO) responded to the WTO in September 2002, confirming, with respect to discrete if it complies with Articles 2 and 4 of the regulation, it can be protected through applying for registration of layout design. China also noted that discretes can be protected under patent laws or as trade secrets. SIA thanks USTR and SIPO for their assistance in clarifying this important point. These new protections are of great importance to U.S. semiconductor producers, as China s capabilities in the semiconductor sector are rapidly advancing. The intellectual property contained in the design of a maskwork remains one of the highest value-added components of 6 Some Information Technology Products' Certification Temporary Methods, January 11, 2002, MII and Ministry of Finance. 3

5 chip manufacturing. SIA is aware of at least two cases where maskwork violations have occurred in China. In one such recent case, a U.S. company learned that several Chinese companies had copied and distributed counterfeit versions of its energy metering integrated circuits. These chips are used to measure the use of electrical energy and are incorporated into electric meters which are installed in apartments, homes and businesses. The U.S. company learned that the Chinese companies were marketing the counterfeit versions to its same customers distributors who supply the provincial and local electric utility boards in China and characterizing their chip as directly substitutable for the U.S. chip. This U.S. company made several trips to China to try and deal with the situation, and met with the Chinese companies it believes were involved in the counterfeiting. Despite their assurances that they would investigate the matter and end the practice, the counterfeiting continues. In fact, the U.S. company understands that the problem is now spreading into India, with the same Chinese companies involved in distribution of the counterfeit chip there. China and India are both important markets for the company. In addition to observing the TRIPS obligations, China should take steps to strengthen trademark enforcement. While Chinese intellectual property laws are generally sound, and Chinese administrative agencies have been cooperative in taking action against trademark counterfeiters, trademark protection laws could nonetheless be improved. For example, China should amend the Criminal Law and the Criminal Procedure Law: (1) to provide more severe penalties for trademark counterfeiting and (2) to provide clearer procedures for criminal adjudication of trademark counterfeiting cases. In addition, China should establish a formal procedure for transferring cases that originated through actions of administrative agencies to criminal courts. Likewise, China should strengthen its judicial system to ensure consistent and effective patent enforcement. Courts have not had much experience in highly technical cases, such as semiconductor or electronics patent cases. Judges need clear rules about the use of technical experts, and the focus should be on identifying competent, unbiased experts rather than local institutions as is the current practice. Moreover, Supreme Court rules should be modified to encourage courts to consider expertise and bias in selecting judicial appraisal institutions and individual appraisers, rather than simply exercising their own discretion to select the appraisal institutions to decide the merits of technical cases. (As far as we know, no foreign firms have ever been allowed to be expert appraisal institutions.) Also, sample purchases of infringing product are often required to establish jurisdiction and damages in patent cases; however, PRC regulations prohibit establishment of private (as opposed to public) entities for investigative services. In addition, damage awards in patent infringement cases have been low. Although statutes provide for damages as reasonable royalties or lost profits, courts hold plaintiffs to a high burden of proof that is not easily met given that no discovery is permitted. Finally, general transparency in the courts should be improved so that all cases (including patent cases) are handled openly and fairly. Specifically, the lack of detailed procedural and evidentiary rules makes litigation in China unpredictable. This weakness increases the cost of doing business in China, and in some cases may lead to unfair results in the adjudication of disputes (a risk increased by the fact that ex parte communications are routinely allowed). 4

6 4. Purchasing By State-Owned And State-Invested Enterprises Enterprises wholly or partially owned by the Chinese central, provincial or local governments (state-invested enterprises) continue to make up a significant portion of the Chinese economy. Reform of China's state sector has been a key priority for the Chinese government for the past several years, and continues as a regular debate subject among the Chinese leadership. While there is agreement that bolder steps should be taken to reform state enterprises, there are differences of opinion over the number of large state-owned enterprises that should be restructured as well as the extent of privatization for state-owned companies. Despite the emphasis on reforms, China's economic policies involve significant state participation, especially in electronics. For example, Shanghai Hua Hong Microelectronics, a state-owned company, formed a joint venture with Japan s NEC in the spring of 1997 to produce state-of-the-art semiconductors in the Pudong New Area outside Shanghai. Given the active government role and future semiconductor production increases both in volume and quality, there is a risk that Chinese officials may (directly or indirectly) encourage other state-invested enterprises to purchase from domestic suppliers. Such discrimination would significantly burden or restrict U.S. semiconductor sales in China in the future. The risk to U.S. manufacturers is increased by reports that the Chinese government will focus more attention on supporting a select group of national champions in the electronics industry as it decreases involvement in other sectors. Given the development of a potentially strong state-invested electronics sector in China, containing both semiconductor producers and consumers, it is essential that Chinese state-invested enterprises make purchases and sales solely on the basis of commercial considerations. As part of its WTO accession, China agreed that its state-owned and invested enterprises will make purchases based solely on commercial considerations, providing U.S. firms with opportunities to compete for sales on non-discriminatory terms and conditions. China also agreed that it would not seek to influence such commercial decisions, unless in a WTOconsistent manner. SIA urges the U.S. Government to closely monitor compliance with these commitments. 5. Trade Regime Reform China should continue the WTO-related reforms of its trade regime to correct anomalies that restrict the operations of U.S. firms in China, specifically: Trading and Distribution Rights. Foreign access to trading and distribution rights will phase in over three years from China's accession. SIA urges the U.S. Government to closely monitor the implementation of these commitments. SIA urges China to move as quickly as possible to provide trading rights to all firms, without discrimination on the basis of nationality or establishment in China. 5

7 Transparency. Several WTO commitments are expected to improve transparency in China s administrative rule-making. For example, China has agreed that only those trade-related measures that are published and readily available will be enforced. China has also agreed to make information on trade-related measures available to WTO members upon request before those measures are implemented or enforced. Additionally, China has committed to establish or designate an official journal for the publication of all trade-related measures and to provide a reasonable period of time for comment to the appropriate authorities before measures are implemented. These are important steps in improving transparency and SIA urges China to fully implement these commitments. The private sector s greatest challenge is to have a meaningful opportunity to comment on draft laws and regulations; currently, Chinese governmental authorities are very inconsistent in allowing industry to provide meaningful input on such measures before they are implemented. Due to lack of stakeholder involvement, the result often is vaguely worded laws and regulations that do not reflect practical implications or adequately balance competing interests. SIA urges the U.S. government to work with the Chinese government in increasing transparency prior to publication of laws and regulations. Specifically, China should refine their administrative law to establish a uniform and effective system at least at the national level that requires all draft laws and rules issued by Chinese ministries to follow the same process, including reasonable access by stakeholders and consideration of relevant comments provided by the regulated community. These refinements could then serve as a model for provincial and local PRC governments. Currency Convertibility and Foreign Exchange. SIA applauds China's recent efforts to liberalize capital account transactions to allow foreign institutions to participate in investment. While the RMB is convertible on the current account, it is in China's interest to move as quickly as possible toward full convertibility of its currency to include the capital account. Such a move would further reduce the uncertainties facing business operations of U.S. firms in China. 6. Investment Restrictions The SIA is pleased that, as part of the final WTO accession agreement, China agreed to fully implement the WTO Agreement on Trade-Related Investment Measures (TRIMs), eliminate export performance and local content requirements, and only impose or enforce laws related to the transfer of technology if they are in accordance with WTO rules. China also agreed that it will not condition investment or import approvals on performance requirements of any kind, including: local content requirements, offsets, transfer of technology, or requirements to conduct research and development in China. SIA urges the U.S. government to closely monitor implementation of and compliance with these obligations. These commitments are important because a number of complex requirements have historically existed and in many cases continue to exist for foreign-owned ventures in China. These rules place a number of restrictions on foreign investment: 6

8 Ownership Restrictions. 100 percent foreign ownership of manufacturing facilities is permitted in China, but it appears that, under an unpublished policy applicable to the electronics industry, 100 percent of such a facility's output must normally be exported. A 70/30 foreign majority-owned electronics joint venture is generally required under the same policy to export 70 percent of its production, but there are no uniform rules; each arrangement is negotiated on a project-specific basis. For instance, in one case Chinese authorities reportedly removed the export requirement from a contract, provided the U.S. firm agreed instead to reinvest all profits earned from domestic sales. Export Targets. Despite the absence of any explicit legal obligations to meet specific export percentages (except for purposes of obtaining preferential tax treatment or qualifying to establish a wholly foreign-owned enterprise) many U.S. companies have been pressed by the Chinese approval authorities to agree to export targets. While such rules are not always enforced, a company can legally be held accountable for noncompliance at a future date. Local Content Requirements. There are localization requirements for parts and materials for products made in China which are not technically legal requirements, yet firms must file localization plans with their foreign investment application. The Chinese Government also audits foreign firms to determine local content. What constitutes local content can be subject to many definitions. For example, importation via a Chinese distributor can qualify a part as "local." Chinese sectoral industrial policies also contain local content requirements. Pressure to Transfer Technology. Ownership restrictions, export targets and local content requirements may be imposed not only as strict legal obligations, but also as quid-proquos for decisions by government officials at both the national and sub-national level. Regardless of their form, these measures are often used as levers to obtain transfer of technology from foreign firms. These measures can have a real and significant competitive impact on U.S. electronics firms, as advanced technology is often the key to competitive success. To the extent that China maintains such measures, U.S. exports in the electronics sector, such as semiconductors, may be restricted. Moreover, such investment restrictions have a negative effect on China, as they discourage the investment necessary to develop a local Chinese electronics industry on a commercially sound basis. In our discussions with Chinese officials, there is a recognition that these policies are inconsistent with China s WTO obligations and would be repealed. SIA supports the immediate repeal of all investment restrictions as required by the terms of the WTO accession agreement 7. Promotional Policies China recently is pursuing several subsidy and promotional policies related to the semiconductor industry which bear monitoring, and require specific action in the case of the VAT rebate. 7

9 VAT Rebate. China's VAT rebate policy on semiconductors, as detailed above, has the effect of stimulating the technological development and capacity of China's domestic industry while distorting global investment patterns. As indicated above, the best solution for U.S. export interests and the development of China's information technology market is for the PRC to reduce or eliminate the VAT rate for all semiconductors and integrated circuits, regardless of origin. Tax Policies. State Council Circular 51, an "unofficial" proposal endorsed by the State Council, contains tax incentives designed to encourage reinvestment in China's semiconductor industry. In a proposal to take effect by 2010, integrated circuit manufacturers in operation in China for less than five years that invest after-tax profits in China will receive a refund of 40 percent of the income tax paid on the reinvested amount, and up to an 80 percent refund if the reinvestment is directed to western China. In addition, an income tax exemption originally applied to manufacturers of circuits 0.25 microns or smaller would be relaxed to the lower threshold of 0.8 microns. The enlargement of the policy to lower-technology chips would primarily target domestic manufacturers, since multinational manufacturers easily meet the 0.25 micron level. The tax exemption is in place for the first two years of operation, followed by a 50 percent tax reduction for the next three years. Manufacturers meeting these criteria would also be eligible for an exemption of tariffs and VAT on raw materials and supplies that currently cannot be manufactured in China due to technical constraints. SIA requests that the U.S. government continue to monitor such incentive policies for WTO compatibility and transparency. Customs Procedures. State Council Circular 51 also provides that integrated circuit enterprises that export more than $50 million annually are eligible for express customs clearance, including advanced and online clearance, express transfer, factory-site inspection, and guaranteed clearance. In addition, imports and exports of these firms are subject to preferential treatment and express clearance regarding commodity inspection and quarantine. Estimate of Potential Increase in Exports The statistical data on Chinese semiconductor demand and output is limited and difficult to estimate given the large amount of unreported shipments from Hong Kong. The size of the current semiconductor market in China is estimated to be approximately $15 billion. The Asia Pacific market is forecasted to be the fastest growing region in the world, and China will be one of the fastest growing markets in Asia. Industry analysts expect China to be the second largest semiconductor market in the world by Given this expected growth in the Chinese electronics market over the coming years, implementation of the reforms discussed above can be expected to increase exports of U.S. semiconductor products by well in excess of $500 million per year. 8